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Critical Enrolled Agent Job To Carefully Characterize Rentals As Passive

February 26, 2012 | Comments: 0 | Views: 175

Taxpayers are typically entitled to deduct on their tax returns any losses incurred in a business. The exception to this general rule occurs when the activity of a taxpayer is considered passive under the Tax Code. Therefore, an enrolled agent tax preparer is careful to examine the circumstances for possible passive activity classification whenever expenses exceed revenue for a taxpayer's business.

The Tax Code considers any business in which the taxpayer does not materially participate as a passive activity. Records are required to substantiate a threshold of hours devoted to material participation. A particularly important element addressed in an enrolled agent study course is that rental activity by anyone other than a real estate professional is always passive regardless of whether the taxpayer materially participates.

Taxpayers hate passive losses because they don't enjoy any tax benefit from them until the disposal year of the passive activity. Annual passive losses accumulate while their only useful purpose is offsetting any passive gains that arise. Attempting to devise a solution around the tax law is a recipe for trouble. A recent Tax Court case emphasizes the passive activity rules from enrolled agent education.

The Tax Code contains an exception about passive rental activity when the rented property is an item from the taxpayer's business in which he materially participates. Under these conditions, an IRS enrolled agent study guide treats the taxpayer as not engaged in a passive activity. This is usually referred to as the self-rental rule. It stipulates that the income or loss under these arrangements is not passive.

The trial in Tax Court involved a physician who rented a commercial building to his incorporated medical practice. The physician materially participated in the business activity of the corporation. In this case, the taxpayer wished to treat the rental activity as passive. That would allow the taxpayer's losses on passive activities to offset the rental income. Consequently, the payment of rent from the medical corporation to the physician became a tax-free transfer of the corporation's tax-deductible rental expense.

The arrangement might have characterized a passive activity if the physician's lease to the corporation was arms length. Unfortunately, the IRS introduced evidence that the so-called rent payments of the corporation to the physician were somewhat ad hoc and not in compliance with the terms of a lease. From 2005 through 2007, the physician's accountant determined the rent after the fact based upon the financial situation of the physician and his medical corporation. In addition, the corporation paid for numerous renovations and improvements to the property over many years.

The terms of a lease executed in 1980 were not followed and the arrangement was ruled as an invalid contract. The building essentially comprised a unit of property for the corporation. Thus, the Court ruled that the self-rental exception applied and the activity is not passive. In summary, an enrolled agent job treats an arrangement as passive when it entails rental by a taxpayer to a corporation. However, if the taxpayer controls the tenant corporation, the absence of a clearly followed rental agreement triggers the self-rental exception.

IRS Circular 230 Disclosure

Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.

Fast Forward Academy is a leading publisher of education for enrolled agent tax preparer and tax professionals. Access to free questions for the enrolled agent study course is available on their website.

Source: EzineArticles
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